the alternative investment fund managers directive



the alternative investment fund managers directive
This briefing note analyses the key threshold exemption
from the scope of the Alternative Investment Fund Managers
Directive (the Directive) and the regulatory capital requirements
for those private fund managers which will be subject to the
Directive, such as private equity, real estate, debt and hedge
fund managers.
A number of private fund managers will be able to rely on an
important size-based threshold exemption from the scope
of the Directive. The FSA’s (now FCA) second consultation
paper on UK implementation (CP 13/9) confirmed that private
fund managers who are able to rely on this exemption will
also be outside the scope of the Directive’s regulatory capital
requirements (see Regulatory Capital below). Broadly, this
exemption applies to managers of closed ended funds whose
assets under management do not exceed €500m.
Specifically, the Directive provides an exemption for AIFMs
which “either directly or indirectly through a company with
which the AIFM is linked by common management or control”
manage portfolios of funds whose assets under management
do not in total exceed €500m (where the relevant funds are (i)
unleveraged and (ii) have no redemption rights within five years
from subscription).
The Level 2 measures provide further guidance / rules on how
to calculate assets under management. This will be undertaken
by reference to the value of assets in the relevant funds by
using the valuation rules set out in the fund’s constitutional
documents. It is clear that uncalled capital commitments are
therefore excluded from the calculation, so only cash and actual
investments will be included. To the extent that any funds have
borrowing or financing arrangements or facilities in place for
capital calls or other short term funding then these will need to
be reviewed to determine whether the funds are unleveraged (if
leveraged the threshold drops to €100m). Particular rules are
included in Level 2 to determine what happens if the threshold
is exceeded, particularly if on a temporary basis. Generally if
the assets are above the threshold for more than three months,
steps will need to be taken to be authorised under the Directive.
In addition, the transitional provisions of the Directive also
provide that if an AIFM manages:
ŠŠ closed ended funds established before 22 July 2013 and
which do not make any additional investments after 22
July 2013; or
ŠŠ closed ended funds whose subscription period has
ended prior to the Directive entering into force and are
constituted for a period of time which expires no later than
22 July 2016,
then it may continue to manage these funds without requiring
authorisation under the Directive.
If a fund manager is only managing funds that fall within the
above two criteria then it will be fully outside the Directive, even
if assets under management exceed €500m.
Where a fund manager manages one or more funds that meet
the above criteria and other funds (e.g. funds which are still
investing or whose life expires after 22 July 2016) then it is
expected that:
ŠŠ the Directive will not apply to the funds which meet the
criteria (e.g. no need to appoint a depositary, no need to
comply with reporting requirements); and
ŠŠ the assets of those funds will not count towards calculation
of the €500m threshold. (This view/interpretation is taken
by the European Commission in its published Questions
and Answers on the Directive).
In its second implementation consultation paper (CP 13/9), the
FCA clarified that funds under management is to be calculated
as the sum of the absolute value of all assets of all funds
managed by the firm, including assets acquired through the
use of leverage. Derivative instruments must be valued at their
market value for these purposes.
If a fund manager has assets above the relevant threshold,
then the full Directive will apply, including the regulatory capital
Recital 23 of the Directive states that a firm must hold capital
“It is necessary to provide for the application of minimum capital
requirements to ensure the continuity and the regularity of the
management of AIFs provided by an AIFM and to cover the
potential exposure of AIFMs to professional liability in respect
of all their activities, including the management of AIFs under a
delegated mandate. …”
The Directive requires an AIFM to:
firms, there will be little material change to their capital
requirements. They must continue to hold one quarter of fixed
annual overheads as regulatory capital but they will also be
faced with new requirements for capital to cover professional
liability risks (as detailed in Appendix 3) and restrictions on their
use of own funds, as explained further below.
ŠŠ have a minimum amount of initial capital plus an additional
own funds capital requirement;
ŠŠ maintain qualifying professional indemnity insurance or
additional own funds to cover professional negligence
liability; and
ŠŠ hold own funds in liquid assets or assets readily convertible
into cash and not in speculative positions.
Under the Directive the regulatory capital requirements are as
An AIFM must perform its regulatory capital calculations on
a quarterly basis. The regulatory capital requirements in the
Directive do not vary for different legal structures: a body
corporate is subject to the same requirements as an LLP,
although how the capital is held within, and contributed to, the
regulated entity will vary accordingly to its legal structure.
ŠŠ an initial capital requirement of at least €125,000; and
The regulatory capital requirements should not apply to subthreshold private fund managers (i.e. firms able to rely on the
exemption discussed in section A) or firms which are otherwise
exempt from the Directive or outside the EU. The Treasury
has confirmed that the existing regulatory regime will continue
to apply to sub-threshold firms although confirmation is still
awaited from the FCA that the existing capital requirements
(primarily the £5,000 “own funds” capital for most private fund
managers) will remain in place for such firms.
However, the “own funds” requirement must not be less than
one quarter of annual expenditure and, in addition:
ŠŠ if the value of assets under management exceeds €250m
then an additional amount of “own funds” equal to 0.02
per cent of the excess over €250m (subject to a cap of
ŠŠ up to 50 per cent of the “own funds” requirement may be
disapplied if the AIFM benefits from a bank guarantee (or
equivalent) for the relevant amount; and
ŠŠ Level 2 contains a requirement for additional “own funds”
regulatory capital of 0.01 per cent of the value of assets
under management to cover professional liability risks (as
set out in Appendix 3). Alternatively, a firm may take out
professional indemnity insurance to cover this amount.
However, we believe take-up of this option amongst
impacted firms is likely to be limited.
For most UK FCA authorised private fund managers which
are currently outside the scope of any EU financial services
directive, the AIFMD will (if they are in scope) impose
significantly higher capital requirements than the existing
domestic regime.
For most private fund managers the one quarter of annual
expenditure calculation (see worked examples below) is likely
to exceed by some margin the 0.02 per cent calculation.
Consequently the basic regulatory capital requirement will be:
Most UK private fund managers (other than hedge funds
managers) are either operators of collective investment
schemes (CIS) or exempt Capital Adequacy Directive (CAD)
firms (advisers and arrangers), so either have an own funds and
initial capital requirement of €50,000 (exempt CAD firms) or
a £5,000 “own funds” capital requirement for fund operators/
managers. These firms will see their capital requirements
increase significantly under the AIFMD.
ŠŠ “own funds” of one quarter of annual expenditure; plus
ŠŠ a dditional “own funds” of 0.01 per cent of assets under
The Directive also requires that “own funds” must be invested
in liquid assets or assets readily convertible to cash in the
short term.
For those existing UK private fund managers which are
currently Markets in Financial Instruments Directive (MiFID)
investment firms and are classified as BIPRU1 limited-licence
Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU).
“Initial capital” and “own funds” are defined in the Directive by
cross reference to their meanings in the Capital Requirements
Directive (CRD). These are two ways of measuring what are
essentially shareholder or members’ funds (for example, after
deducting adjustments for losses). Generally there are methods
of calculating/measuring financial resources but they refer
to different combinations of certain capital items (e.g. paid-up
share capital).
The FCA has proposed a reorganisation of its handbook such
that CPM firms (which will be the majority of private fund
managers within the Directive (i.e. those who only manage/
operate funds)) will be covered by a new Chapter 11 in
IPRU(INV). CPMI firms will be covered by the existing General
Prudential Sourcebook (GENPRU) and Prudential Sourcebook
for Banks, Building Societies and Investment Firms (BIPRU)
(as amended), which currently apply to them.
As mentioned above, own funds must be invested in liquid
assets or assets readily convertible into cash in the short term
and not in speculative positions. This restriction will therefore
generally prevent an AIFM from using own funds as working
As mentioned above, private fund managers will be subject
to an initial capital requirement set out under the Directive of
€125,000 and this will need to be met out of “own funds” on an
ongoing basis. Thereafter to calculate the overall capital for a
CPM firm the following elements will be relevant: (i) initial capital
requirement; (ii) a percentage of assets under management;
(iii) an expenditure based minimum; and (iv) an additional
own funds capital requirement in respect of risks arising from
professional negligence.
The first FSA (now FCA) consultation paper on implementation
of the Directive (CP12/32) set out the FCA’s core proposals
for the implementation of the regulatory capital provisions.
The FSA’s (now FCA) second consultation paper (CP 13/9)
confirms the basic approach outlined in CP 12/32 and clarifies
certain technical details. Importantly, these include confirmation
that private fund managers that are able to rely on the sizebased threshold exemption (outlined in section A above) will
be outside the scope of the regulatory capital requirements
imposed by the Directive. The FCA also confirms that non-AIF
operators of collective investment schemes will not be subject
to the Directive’s regulatory capital regime. However, subthreshold firms that act as AIFMs of authorised AIFs (such as
non-UCITS retail schemes) will be caught by the requirements.
Pulling these together, the FCA’s interpretation is therefore that
a CPM firm is required to maintain own funds of:
(a) the greater of:
The FCA is proposing two types of regulated firms within the
scope of the Directive that will be relevant for private fund
(i)€125,000 plus 0.02 per cent of the portfolio of
relevant AIFs under management over €250m; and
(ii)one quarter of the firm’s relevant annual expenditure;
(b)an additional amount equal to 0.01 per cent of the value of
assets under management in AIFs.
The own funds (other than the initial €125,000 initial capital)
must be invested in liquid assets (see further below).
The first is a Collective Portfolio Management (CPM) firm,
which will be a firm that undertakes external collective portfolio
management of AIFs but does not provide any MiFID services
(such as segregated investment management activities). The
second type is a Collective Portfolio Management Investment
(CPMI) firm, which will be a firm that provides collective portfolio
management services to AIFs and MiFID services, such as
segregated investment management/activities. While a firm
cannot be authorised under both AIFMD and MiFID, the AIFMD
does allow an AIFM to perform certain MiFID activities, including
segregated investment management, investment advice and the
reception and transmission of orders in financial instruments.
As mentioned above CPMI firms will be AIFMD firms which
also provide MiFID services, such as segregated portfolio
management activities. The FCA’s view (as set out in
CP12/32) is that such a firm will generally be treated as
a BIPRU limited licence firm, but only subject to the Pillar
1 requirements. Importantly, this will mean that such firms
will not be required to prepare an Internal Capital Adequacy
Assessment Process (ICAAP). These firms are currently
subject to GENPRU/BIPRU regulatory capital rules so their
regulatory capital is unlikely to materially alter as a result of
becoming an AIFM.
CPMI firms must hold own funds equal to the higher of the
GENPRU and BIPRU requirement for a limited licence firm
(which is, in effect, the existing regulatory capital treatment for
such firms) and the following own funds requirement:
Each CPM Firm will be required to complete a new reporting
form (FCA 066), which will demonstrate whether it meets its
ongoing capital requirements. These will be required to be
submitted on a quarterly basis, alongside Form FSA 030 and
a balance sheet (Form FSA 029). In addition a CPMI Firm will
also be required to submit Form FSA 067 which will contain
supplementary information. Each firm will also be required to
submit an annual report and accounts and a solvency statement
within 80 days of their accounting reference date.
ŠŠ the higher of (i) €125,000 plus 0.02 per cent of the
portfolio of relevant AIFs under management over €250m
and (ii) one quarter of the firm’s relevant fixed expenditure;
ŠŠ an additional amount equal to 0.01 per cent of the value of
assets under management in AIFs.
CPM firms will be required to calculate their initial capital and
own funds on the basis of Table 7.4 in IPRU(Inv) 11, with a
distinction between Tier 1 and Tier 2 capital, as set out in
Appendix 2.
The FCA’s view is that whilst the initial capital requirement (that
is, €125,000) must be in place once a firm is first authorised
it must be met out of “own funds” on an ongoing basis, as in
its view this better reflects the continuing obligations of the
regulated firm.
Example 1
In the example below it is assumed that the private fund
manager has €750m of assets under management and annual
expenditure of €4m.
Own funds will be required to be invested in liquid assets or
assets readily convertible to cash in the short term. This will
apply to all regulatory capital, except the €125,000 initial capital
Own Funds Requirement
Higher of:
(a)€125,000 + 0.02 per cent of
AUM in excess of €250 million =
The FCA is proposing a “proportionate” interpretation of the
term “assets readily convertible to cash in the short term” such
that it will include assets which could be realised for cash within
one month and this will therefore include cash, readily realisable
investments that are not held for short term resale and also
Represented by
(b) ¼ of annual expenditure =
0.01% of AUM
Total own funds requirement
Annual expenditure will generally only include fixed expenditure,
and not variable or discretionary expenditure and will therefore
cover (amongst other things) salaries; guaranteed bonuses;
rent; and insurance premiums. AIFMs will be required to provide
income statements (Form FSA 030) to the FSA on a quarterly
basis, which will contain the expenditure figure used as the
basis for the fixed overheads requirement calculation. Form
FSA 030 sets out the lines of expenditure that are included
and these are set out in Appendix 1. The draft FSA rules also
provide that certain items of expenditure are not deemed to
be fixed and will therefore be deducted. This includes staff
bonuses (provided they are not guaranteed) and employees’/
directors’ shares in profits. These are also set out in Appendix 1.
€1,000,000 of eligible LLP members’ capital
€75,000 interim profits (independently verified by auditor)
Liquid Assets Requirement
Higher of:
(a)0.02 per cent of AUM in excess of
(b) ¼ of annual expenditure =
0.01 per cent of AUM
Total Liquid Assets Requirement
Represented by
Private fund managers should now determine whether or
not they will be able to rely on the threshold exemption and/
or transitional provisions discussed in Section A. Those
private fund managers who will be required to comply with
the regulatory capital requirements of the Directive from
implementation should calculate their regulatory capital
requirements under the Directive based on their current balance
sheet and expenditure. Clearly many firms will face significant
increases in regulatory capital and while expenditure can be
managed to an extent (for example switching guaranteed
remuneration/salaries to bonuses or allocation of profits) most
expenditure is relatively stable. In addition the requirement to
hold the bulk of regulatory capital as liquid assets will decrease
the ability to use such resources for other purposes.
≥ €1,075,000 of liquid assets or assets readily convertible to
cash in the short term
In this example, ¼ of annual expenditure results in a higher
figure for stage (1) of both the own funds requirement and the
liquid assets requirement calculations. As noted above, this is
likely to be the case for most UK private fund managers as a
firm would need to have very low expenditure relative to assets
under management for ¼ of annual expenditure to be a lesser
sum than 0.02 per cent of AUM (even adding €125,000 in
the case of the own funds requirement). This is illustrated in
example 2 below.
Example 2
In this example, it is assumed that the private fund manager has
€5bn of assets under management and annual expenditure
of €3m.
Own Funds Requirement
Higher of:
(a)€125,000 + 0.02 per cent of
AUM in excess of €250 million =
(b) ¼ of annual expenditure =
0.01% of AUM
Total own funds requirement
Represented by
€1,575,000 of eligible LLP members’ capital
Liquid Assets Requirement
Higher of:
(a)0.02 per cent of AUM in excess of
(b) ¼ of annual expenditure =
0.01 per cent of AUM
Total Liquid Assets Requirement
Represented by
≥ €1,450,000 of liquid assets or assets readily convertible to
cash in the short term
A firm’s relevant fixed expenditure is the amount described as total expenditure in its final income statement (FSA030) for the
previous financial year and is made up of the following items:
(1) Commissions and fees;
(2) Staff costs – salary;
(3) Staff costs – guaranteed bonus;
(4) Foreign exchange losses;
(5) Accommodation;
(6) Interest expense; and
(7) Other expenditure.
= Total expenditure
The following variable items should then be deducted from the total expenditure figure above (to the extent they are included within
such expenditure):
(1) Staff bonuses, except to the extent that they are
(2) Employees’ and directors’ shares in profits, except to the
extent that they are guaranteed;
(3) Other appropriations of profits;
(4) Shared commissions and fees payable which are directly
related to commissions and fees receivable, which are included
within total revenue;
(5) Interest charges in respect of borrowings made to finance
the acquisition of the firm’s readily realisable investments;
(6) Interest paid to customers on client money;
(7) Interest paid to counterparties;
(8) Fees, brokerage and other charges paid to clearing houses,
exchanges and intermediate brokers for the purposes of
executing, registering or clearing transactions;
(9) Foreign exchange losses; and
(10) Other variable expenditure.
Own funds is the sum of Tier 1 capital and Tier 2 capital. Tier
2 capital must not exceed 100 per cent of Tier 1 capital.
paid-up share capital (excluding preference shares);
share premium account;
audited reserves and interim profits;
non-cumulative preference shares; and
eligible LLP members’ capital.
Eligible LLP members’ capital (item 5) can only be included in
Initial capital if specific and general conditions are met. The
specific conditions are that the members’ capital consists of the
members’ capital account. The members’ capital account must
meet the following conditions:
ŠŠ it is an account into which capital paid by the members is
The sum of items 1 to 5 constitutes Initial capital. Tier 1
capital is Initial Capital less each of the deductions in items 6 to
10 below:
investments in own shares;
intangible assets;
material current year losses;
excess LLP members’ drawings; and
ŠŠ a member may only withdraw capital if:
ŠŠ he ceases to be a member and an equal amount of capital
is contributed by existing or replacement members;
ŠŠ the LLP is wound up or dissolved; or
ŠŠ the LLP has ceased to be FCA authorised.
The general conditions for the members’ capital are that:
ŠŠ it is fully paid up and the proceeds are immediately and
fully available to the firm;
10. material holdings in credit and financial institutions.
Tier 2 capital is the sum of items 11 to 15 below:
ŠŠ it cannot be redeemed, except in the circumstances set
out in the specific conditions;
11. revaluation reserves;
ŠŠ any coupon is non-cumulative;
12. fixed term cumulative preference share capital;
ŠŠ it is loss absorbent;
13. long-term qualifying subordinated loans;
ŠŠ the amount of the item is net of any foreseeable tax
14. other cumulative preference share capital and debt
capital; and
ŠŠ it is available to the firm for unrestricted and immediate
use to cover risks and losses as soon as they occur;
15. qualifying arrangements.
ŠŠ it ranks for repayment on a winding up of the firm no
higher than a share of a Companies Act company would;
ŠŠ the firm is not obliged to pay a coupon on the capital at
any time.
Once the calculation has been undertaken (and recalculated on
a quarterly basis) the figure must exceed the initial capital and
own funds requirement, also calculated on a quarterly basis.
Professional liability risks include, without being limited to,
risks of:
loss of documents evidencing title of assets of the AIF;
misrepresentations or misleading statements made to the
AIF or its investors;
acts, errors or omissions resulting in a breach of:
legal and regulatory obligations;
duty of skill and care towards the AIF and its
fiduciary duties;
obligations of confidentiality;
AIF rules or instruments of incorporation;
terms of appointment of the AIFM by the AIF;
failure to establish, implement and maintain appropriate
procedures to prevent dishonest, fraudulent or malicious
improperly carried out valuation of assets or calculation of
unit/share prices; and
losses arising from business disruption, system failures,
failure of transaction processing or process management.
If you would like further information or specific advice please contact:
DD: +44 (0)20 7849 2495
[email protected]
MAY 2013
T: +44 (0)20 7831 9222 F: +44 (0)20 7831 9607 DX 138 Chancery Lane
This note is intended to provide general information about some recent and anticipated developments which may be of interest.
It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.
Macfarlanes LLP is a limited liability partnership registered in England with number OC334406. Its registered office and principal place of business are at 20 Cursitor Street, London EC4A 1LT.
The firm is not authorised under the Financial Services and Markets Act 2000, but is able in certain circumstances to offer a limited range of investment services to clients because it is authorised and regulated by the Solicitors Regulation Authority.
It can provide these investment services if they are an incidental part of the professional services it has been engaged to provide. © Macfarlanes May 2013

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